Corporate officers don’t like the unpredictable costs that come along with litigation, which make budgeting difficult.
- Risk Mitigation
First, using outside financing allows companies to mitigate the risk from litigation. It’s a fact of life for large companies that they will eventually have to sue somebody but even when the claim has merit and it’s important to protect the business, it’s not news that the C-suite will not cheer the budget drain, even if it’s a healthy company. Further, litigation is inherently unpredictable; there may be unpleasant surprises during discovery, and in the end, the case is in the hands of a judge or jury. Corporate officers don’t like that risk, or the unpredictable costs that come along with litigation, which make budgeting difficult.
- The Benefits of Off-Balance Sheet Financing
Litigation financing has clear advantages for the plaintiff company, starting with the fact that it enables the company to take the litigation cost off its balance sheet. At a publicly traded company, litigation costs are reported on the company’s statement of profits and losses as an expense against profits. Any eventual financial recovery from the litigation would be reported too but it would be reported as an “extraordinary event” rather than profit, and that could be years down the road. Thus, litigation drags down the company’s profitability without a corresponding benefit at the end. By financing the litigation, however, a corporate law department can cover its legal costs using the litigation funder’s capital and take the litigation expense off its balance sheet entirely. That means the statement of profits and losses more accurately reflects the company’s true profitability. For companies focused on valuation, for example if the company is anticipating a capital raise, acquisition, IPO, or other strategic transaction where its valuation is important, keeping costs off-balance sheet has huge benefits. Especially when valuation is calculated by applying earnings multiple, every dollar not subtracted as legal costs means multiple dollars of value in a valuation.
Topics: In-House Counsel, Litigation Finance, Off-Balance Sheet
Work Cited: Lake Whillans | March 25, 2020